Aref Assaf, The game of oil speculators exposed

Aref Assaf
July 25, 2008

No reason to thank Saudi Arabia or OPEC for the recent welcome decline in oil prices. Our hats are off to recent US- based monetary and economic statements which have pushed down the worldwide price of crude oil  to around $121.00. The decline in global crude prices over the last few days has settled the debate whether it's market speculators or surging demand from India and China that has been pushing oil's relentless rally for over a year now.

Crude plunged $6.44 from the previous week's all-time-high closing of $147.27 a barrel on Tuesday, recording the steepest single fall in 17 years on NYMEX (New York Mercantile Exchange). On Friday, prices slid another $4.03 a barrel and the subdued sentiments remained through the week.

On the day of oil's biggest fall, prices had swung from a high of $146.73 a barrel to a low of $135.92. There were no apparent reasons for oil's yo-yo act before the plunge. There were no reports of any escalation in tensions between the US and Iran, sudden slump in supplies due to attack on facilities in big producer country like Nigeria or major disruption in global shipping lanes or refining operations due to a hurricane. Not even any significant change in the value of the greenback, the currency for global oil trade.

Two things seem to have scared market players. The first trigger was Federal Reserve chairman Ben Bernanke's statement  last week, warning of even more pressures on the US economy, already reeling under the sub-prime crisis and continued slowdown in the housing sector. The second was OPEC's forecast that said world demand will rise by 900,000 bpd next year, which is 100,000 bpd lower than seen this year.

Both these statements made fears of a dip in demand look real. In the US, the biggest oil guzzler in the world, motor fuel demand has dropped 5%. Bernanke's warning only reinforced apprehensions of a further demand squeeze in coming months as consumer prices jumped 5% as compared to June last year and recorded the biggest monthly jump since 1982.

This was not the first time oil prices were reacting to monetary policy pronouncements or analysis. For a long time now, oil has slid away from its reservoir roots and been guided more by speculative investments than simple demand-supply mechanisms. This has been more pronounced ever since the US sub-prime crisis broke out, forcing speculative investors to pump their money heavily into commodities, particularly oil and gold.

Consider this: The first time oil broke records in the last week of June was after the US central bank left its benchmark lending rates unchanged. It took crude five weeks to reach $140 bpd from $130, which was first hit on May 21. On June 6, prices rose by $10.75 a barrel, the highest one-day jump in history, a day after the European Central Bank signaled it could raise EU's interest rates. On the back of the Fed's decision to hold rates steady, higher European rates exposed to dollar fluctuations anyone betting on lower crude prices.

There's more. Last month, even after Saudi Arabia said it will pump 200,000 bpd extra, oil jumped again as punters realized that Riyadh would have even less spare capacity in case supplies were disrupted due to rebel attacks in Nigeria and Iraq or a hurricane hit the Gulf of Mexico or any other major offshore production area.

Despite these tell-tale signs of speculators having a field run of the market, the world oil community remained divided. The US and other developed economies kept blaming surging demand from India and China for shooting prices. Their view was articulated by the US-backed International Energy Agency, the Paris-based organization that tracks energy demand in developed economies. On its part, OPEC rejected the contention, rightly blamed it on speculators but refused to do much about it.

At the Madrid World Petroleum Congress, billed as the Olympics of oil that takes place every three years, OPEC chief and Algeria's energy minister Chakib Khelil went so far as to specify that 60% of the increase in prices is because of speculation but said the cartel will not intervene in the market to calm prices. 

The often noted excuse for rise in crude price advocated by small section of the oil analysts has been ascribing the relentless rise in crude prices in recent months to the spurt in demand for oil from India and China. While China and India account for over one-third of the global population, their combined oil consumption is less than one-eighth of the world's consumption. The problem of both consumption and price fixing lies somewhere between the Atlantic and the Pacific oceans.

Such forceful statements in defense of demand from India are, however, nothing new. At the Third OPEC Heads of State Summit in Riyadh last year, the cartel's secretary-general Abdalla Salem el-Badri  had for the first time denied Asian demand was responsible for oil's rally. "We welcome the demand from them (from India and China). We are ready to cooperate with them to fulfill their demand for oil. Let me say clearly, India and China are not responsible for rise in prices." 


What all this means for consumers in New Jersey is that, as of now, out of every dollars of the increase in fuel prices, they can blame speculators for 60 cents.  Pundits may feel this is an oversimplification of a complex issue. But that is how it appears to a commoner who does not know the secretive intricacies of the stratospheric world cradled in Manhattan skyscrapers and dominated by men in designer suits. The situation will not change much till such time when punters pump their money out of oil and into other opportunities to make a quick buck. For our pockets and gas tanks are running on empty.